FINANCE AND DEVELOPMENT
RESEARCH PROGRAMME
WORKING PAPER SERIES
Paper No 38
RESPONDING TO FINANCIAL CRISIS:
BETTER OFF WITHOUT THE IMF?
THE CASE OF JAMAICA
Colin Kirkpatrick
IDPM, University of Manchester
and
David Tennant
Department of Economics
University of the West Indies, Jamaica
February 2002
ISBN:
1 904143 09 1
Series Editor:
Further details:
Published by:
Colin Kirkpatrick
Maggie Baldwin, Marketing and Publicity Administrator
Institute for Development Policy and Management, University of Manchester,
Crawford House, Precinct Centre, Oxford Road, MANCHESTER M13 9GH
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1
RESPONDING TO FINANCIAL CRISIS: BETTER OFF
WITHOUT THE IMF? THE CASE OF JAMAICA
Colin Kirkpatrick
Institute for Development Policy and Management
University of Manchester, UK
and David Tennant
Department of Economics
University of the West Indies, Jamaica
Summary
The adverse economic and social effects of the financial crises that have afflicted many
developing countries in recent years, have highlighted the need to develop a policy response
which addresses the vulnerability of financial systems to systemic instability and crisis. The
paper examines the experience of Jamaica, a country which successfully managed a financial
sector crisis during the 1990s, without the assistance or involvement of the IMF. Lessons are
drawn from the Jamaica case study for the reform of IMF support to developing countries in
managing financial sector instability and crisis.
Key words: financial sector crisis; financial sector policy; IMF; Jamaica.
1
Introduction
The financial crises that have swept across many developing countries in recent years have
been a painful reminder that market failure is endemic to financial markets (Stiglitz, 1994).
Largely unforeseen, these crises have imposed severe economic and social costs on the
affected economies and threatened the stability of the international monetary system. The
recurrence of financial crises in the developing world, and the adverse effects which they
have had on economic growth, have highlighted the need to develop a policy response which
addresses the vulnerability of the financial system to systemic instability and crisis.
The international financial institutions (IFIs) have been heavily involved in formulating the
developing countries’ policy response to financial crisis, as sources of both external financial
support and prescriptive advice. The International Monetary Fund (IMF) in particular has
played a central part in the IFI’s contribution to financial crisis resolution in developing
countries, both in its traditional role of providing short-term balance of payments finance and
in its more recent role as provider of longer-term development finance.
The Fund’s involvement in managing the Asian financial crisis of 1997 has provoked a
strongly contested discussion as to the appropriate policy response to systemic financial
crisis. This debate has gone on within the Fund itself, between the Fund and its major
partner, the World Bank, and among the wider international research and policy communities
(IMF, 1999b, 2000b; Stiglitz, 1998, 1999).1 The Fund’s policies of closing troubled financial
institutions and concentrating on restoring stability in the foreign exchange markets by
raising interest rates, have been widely criticised as further weakening public confidence in
2
the financial system, and damaging the social capital and political stability upon which
economic recovery and growth depend.
The perceived failure of the IMF in managing recovery from the Asian crisis has stimulated a
wider and more fundamental debate on the future role of the IMF within the overall
international financial architecture. Some critics of the Fund have argued that the Fund
should ‘return to basics’, concentrating exclusively on its traditional role of providing shortterm balance of payments support to stabilise the economy and preventing outflows of
foreign exchange reserves, which would require the IMF to abandon its more recently
assumed role of providing longer-term adjustment finance intended to strengthen the supply
side of the economy.
This paper speaks to both these issues, by providing a detailed case study of the government’s
policy response to financial crisis in Jamaica in the 1990s. Prior to the 1990s, Jamaica had a
long and often troubled history of involvement with the IMF. By the early 1990s, however,
Jamaica had met its outstanding commitments to the Fund and decided to avoid further
engagement with the IMF, if possible. Jamaica provides, therefore, a particularly interesting
(and atypical) case study of a developing country which managed the crisis in its financial
sector during the 1990s without IMF assistance or involvement.
The remainder of the paper focuses on Jamaica’s response to, and management of, its
financial crisis. It will be argued that the outcomes of the measures adopted in addressing the
crisis were superior to what might have been the outcome if the standard ‘Asian financial
crisis’ IMF prescription had been adopted instead. The lesson drawn will be that crisis
management programmes, as with any form of economic policy management, are more likely
to succeed if they draw on the national stakeholders’ expertise and knowledge of the
particular structural characteristics, past experience and political economy of the affected
economy.2
There are a further five sections to the paper. The next section describes the evolution of
Jamaica’s financial sector, and outlines the anatomy of the crisis. Section 3 discusses
various explanations of the crisis, and Section 4 provides a detailed examination of the
Jamaican government’s response to the crisis. Section 5 evaluates its response using a
counterfactual based on a hypothetical IMF response. The final section summarises the
general lessons that can be drawn from the Jamaican experience.
2.
ANATOMY OF THE JAMAICAN FINANCIAL CRISIS
Jamaica, a relatively small island of 2.5 million people, is known more for its music and
beaches than for its financial prowess. However, the Jamaican financial system has been
growing and developing to keep pace with the changing domestic and international
environments. As part of structural adjustment loan agreements with the World Bank,
economic reform in Jamaica has been aimed at integrating the domestic economy into the
global economy (McBain, 1997: 132). This has included the liberalisation of the financial
sector, and has resulted in the growth in the number of financial institutions operating in the
island and in the range of financial services being offered. The banking and insurance
services are now major sectors of the Jamaican economy, and are regarded as exemplars of
the country’s open, free-market policies.
3
However, the rapid expansion of Jamaica’s financial sector between 1991 and 1997 exposed
significant problems within the banking and insurance sectors, as evidenced by capital
shortages and asset quality problems at several financial institutions. Since 1993, the
Minister of Finance has placed 12 financial institutions under temporary management and
intervened in 10 financial institution groups, which includes banks, insurance companies and
non-core businesses.
The evolution of the financial sector in Jamaica has been very similar to that in much of the
developing world, particularly South East Asia, having undergone five distinct phases in its
development – pre-liberalisation, liberalisation, post-liberalisation/pre-crisis, crisis and postcrisis.3
Pre-Liberalisation
Jamaica went through a period of strong financial repression in the 1970s to mid-1980s
characterised by strong public sector leadership, government involvement in the operation
and development of financial institutions, bureaucratic controls on entry, and the dominance
of commercial banks in the financial intermediation process (Peart, 1995: 3).
Firm control over the financial system was part of the government’s attempt to adhere to
policies agreed with the IMF under stabilisation programmes, focused on constraining the
growth of money supply and achieving a market-determined exchange rate. Credit controls
and high reserve requirements were used to contain demand (McBain, 1997: 145).
Additionally, the central bank administered a minimum savings deposit rate which was an
important determinant of the overall level and structure of interest rates, and was used as a
tool to reduce domestic demand. Supplementary measures such as preferential interest rates
and central bank rediscount financing to priority sectors were also implemented (Peart, 1995:
6).
The effect of financial repression in Jamaica was adverse. At the end of 1989, the real
savings rate for commercial bank deposits was only 0.8 per cent and by the end of 1990, this
position had worsened to –11.8 per cent (Bank of Jamaica, 1999: 52 and 107). This had
adverse implications for the rate of growth in domestic savings, and thus on the amount of
funds available for investment. Financial repression also led to a dualistic financial sector,
particularly through the prevalent ‘partner system’ and various money lending schemes.
Furthermore, inefficiency in the financial sector was rife, as credit ceilings and directed credit
contributed to allocative inefficiency. Relatively large interest rate spreads and low
competition within the banking system exacerbated this inefficiency.4
Liberalisation
Attempts at financial liberalisation in Jamaica took place in two clearly defined stages. The
first phase of liberalisation was between 1986 and 1988 as part of a structural adjustment loan
agreement with the World Bank. The principal objectives of the financial reform programme
were the creation of an environment conducive to efficient financial intermediation, and the
strengthening of the central bank’s ability to influence money and credit variables (Lim,
1991: 6). The reform of interest rate policies, and the development of the money and capital
markets were two key areas of focus at the time (Peart, 1995: 7).
4
This initial attempt at financial liberalisation involved the removal of credit controls, and the
phasing out of the statutory reserve requirement of commercial banks, which had traditionally
been used as a means to finance the fiscal deficit. The privatisation of the National
Commercial Bank, a major commercial bank, was also initiated in 1986. Additionally, there
were attempts to reform the interest rate policy. First, the central bank introduced a market
determined interest rate instrument (the CD) to facilitate its open market operations and
second, the savings deposit rate was linked to a market determined interest rate – the average
weighted term deposit rate of the commercial banks.
In 1989, following the onslaught of Hurricane Gilbert, this financial reform programme was
interrupted. The government was forced to re-impose the statutory reserve requirement and
credit ceilings, and to increase the savings deposit rate. This was in response to growing
bank liquidity, caused by the reinsurance inflows and increased government expenditure
associated with the rehabilitation effort (Lim, 1991: 37; Peart, 1995: 12).
The second, accelerated phase of financial liberalisation started in Jamaica in late 1990 to
early 1991. In accordance with IMF targets, the central bank removed the ceilings placed on
banking system credit, and announced the unification of the cash reserve and liquid assets
ratio. Savings rates were totally deregulated, with the commercial banks now being
authorised to set their own rates. At about the same time the foreign exchange system was
liberalised. Jamaica began dismantling exchange rate controls in 1990 and had formally
abolished all remaining controls by 1992. Since then, the exchange rate has been determined
by market conditions and the movement of foreign exchange in and out of the country is
unrestricted.
Post-Liberalisation/Pre-Crisis
The rapid liberalisation of the 1990s led to significant changes in the financial landscape. In
the post-liberalisation era, there was rapid asset expansion and deepening within the financial
sector, with the operations of commercial banks and NBFIs increasing significantly. By the
end of 1997, the assets of the commercial banks represented 50 per cent of the total assets of
the financial sector. Of this amount, three large banks accounted for 75 per cent (Stennett et
al., 1998: 11). Additionally, the number of NBFIs increased from 8 in 1985 to 25 in 1993,
with their assets increasing in nominal terms from J$1.4 billion in 1986 to J$11.4 billion in
1993 (Peart, 1995: 15).
There was also the emergence of large financial conglomerates during this period. They were
mainly created by insurance companies to take advantage of the financial arbitrage provided
by the existence of differential cash reserve requirements, and differences in the level of
supervision over the various sub-sectors of the financial system (Green, 1999: 4). These
large conglomerates were usually composed of a merchant bank, a commercial bank, a
building society, an insurance company and other business firms. They often had complex
structures of inter-company share holdings, interlocking boards of directors, common
management and extensive inter-group transactions (Stennett et al., 1998: 12). Following
liberalisation, these new entities expanded aggressively, venturing not only into more
innovative financial activities, but also stretching beyond the boundaries of prudent financial
practices into investment in real sector activities. These conglomerates often engaged in the
acquisition and operation of agricultural enterprises and tourism ventures (Green, 1999: 13).
Due to the interlocking nature of these so-called “One-Stop Financial Supermarkets”, the risk
of contagion was high, and the entire sector became vulnerable to financial instability.
5
The rapid expansion of lending to the private sector was also a feature of the postliberalisation era. Green (1999: 4) notes that there was an unsustainable credit boom in
which loans and investments were made without proper risk assessment or appropriately
valued collateral. The private sector’s allocation of banking system credit increased
markedly throughout the period, moving from J$2.9 billion in 1985 to J$21.5 billion in 1993.
A particularly worrying feature of this expansion was the rate of growth in consumer-oriented
credit relative to credit for productive activity.
One of the reasons for this credit boom was the inflow of capital associated with the
liberalisation of the foreign exchange regime, as a result of which foreign currency deposits
in Jamaican banks and NBFIs increased significantly (Green, 1999: 4). Commercial bank
balances grew by 55 per cent from 1993 to 1995, and those of merchant banks grew by over
200 per cent in the same period. Foreign currency loans also increased by over 100 per cent
each year between 1992 and 1994 (McBain, 1997: 146). However, also associated with
foreign exchange liberalisation was a rapid depreciation in the exchange rate, which moved
from US$1.00=J$7.90 at the end of September 1990 to US$1.00=J$27.38 by the end of
March 1992. This slide in the currency pushed inflation to over 80 per cent for fiscal year
1991/92 (Stennett et al., 1998: 7).
Following the dramatic expansionary period of the early 1990s, the fortunes of the Jamaican
financial sector changed rapidly by the mid 1990s. This was evidenced by a number of
factors. Private sector credit which grew by almost 70 per cent in 1993, slowed significantly
to 25 per cent in 1996 and actually declined in 1998. The profitability of the sector was also
declining, with a reduction in the return on assets of commercial banks. There was also a
deterioration in the banking system’s capital base - whereas the international standard for
capital adequacy is set at 8 per cent, in 1995 most Jamaican banks were below 3 per cent
(Green, 1999: 21).
The problems in the Jamaican financial sector were further reflected in the high level of nonperforming loans (NPLs). NPLs as a percentage of total loans in commercial banks grew
from 7.4 per cent in 1994 to 28.9 per cent in 1997. There was also evidence of a high level of
problematic related-party loans, a large percentage of which were associated with the
relationship between insurance companies and their related commercial banks (Green, 1999:
21-22).
Finally, the Jamaican financial institutions, especially the insurance companies, were plagued
by the mismatch of assets and liabilities. In the early 1990s, the life insurance industry
entered into the aggressive marketing of short-term and equity-linked products, by offering
high rates of return. Imprudent investment of these short-term savings in long-term assets,
mainly real estate, resulted in illiquidity problems for the life insurance industry and by
contagion, the affiliated commercial banks, when the equity market collapsed in 1992 and
policyholders sought to encash their policies. The illiquidity problems associated with these
encashments were too much for the troubled Jamaican financial sector to bear, and the full
onslaught of the crisis was felt in 1997.
Crisis
The crisis in the Jamaican financial sector was severe, although not accompanied by a
currency crisis. It started because of illiquidity problems in the life insurance industry, which
6
were precipitated by the downturn in the real estate and stock markets. These problems
quickly spread to affiliated commercial banks, which were then forced to turn to the central
bank for liquidity support. In 1995 one commercial bank received J$4.0 billion in liquidity
support, and in 1996 approximately J$6.0 billion was given to two other banks. As the
problems in the sector became more evident, there was a “flight to quality” within the
domestic financial system. Depositors withdrew their savings from what were perceived to
be weak institutions, mainly indigenous with local managers, and deposited these funds with
branches of foreign banks (Green, 1999: 24). This necessitated government intervention.
Beginning in 1993 the Ministry of Finance has had to place 12 financial institutions under
temporary management, and has intervened in 10 financial institution groups.
Post-Crisis
The Jamaican government’s initial response was to close the distressed institutions.
However, as the problem was seen to be more extensive than at first estimated, a new strategy
was developed to avert a collapse of the system. A study was done to evaluate the extent of
the problem, and a number of fast-track items of legislation were introduced to strengthen the
regulatory framework (Green, 1999: 4). Also, two institutions – Financial Institutions
Services Limited (FIS) and the Financial Sector Adjustment Company Limited (FINSAC)
were created by the government to facilitate the resuscitation of the failed banks and to
proceed with the restructuring and reorganisation of the financial sector. The operations of
FIS were subsequently merged with FINSAC. As at January 2000, the total cost of
FINSAC’s intervention in the financial sector amounted to J$106.9 billion (Government of
Jamaica, 2000: 47).
3.
THE CAUSES OF THE JAMAICAN FINANCIAL CRISIS
It has been shown that financial sectors are more vulnerable to crises following liberalisation.
Demirguc-Kunt and Detragiache (1998a: 303) note that over the past 30 years many countries
have liberalised their financial systems. However, “during this period, the frequency of
systemic banking problems has increased markedly, raising the possibility that greater
fragility might be a consequence of liberalisation” (Pleskovic and Stiglitz, 1998: 6). Stiglitz
(1998) more directly states that, “theory would predict that financial market liberalisation
preceding the development of adequate regulatory capacity is likely to lead to an enhanced
likelihood of a financial crisis.” There are numerous reasons for the increased vulnerability
of financial systems to crises following liberalisation, most of which have been clearly
evidenced in the Jamaican crisis.
Liberalisation increases banks’ opportunities to take on risk as once interest rate ceilings and
credit controls are lifted, banks can finance riskier ventures in exchange for higher promised
returns. While this may result in the increased funding of socially desirable projects, “banks
in newly liberalised systems are likely to be particularly vulnerable because the skills needed
to screen and monitor risky borrowers, (and) manage risky loan portfolios… can be acquired
only gradually through learning by doing” (Demirguc-Kunt and Detragiache, 1998a: 306).
Second, financial liberalisation also engenders mechanisms that facilitate increased moral
hazard. One such mechanism involves agency conflicts, which arise because of
informational imperfections. A key imperfection of information is the asymmetric
distribution of information, with insiders (the bank owners and managers) having an
informational advantage over outsiders (their depositors and other creditors). This leads to
7
agency conflicts between depositors and banks because depositors are unable to perfectly
monitor and therefore control the decisions of banks, and between debtors and creditors
because of the fixed value nature of contracts. Agency conflicts give bank equity holders the
incentive to gamble with their depositors’ money in order to maximise the value of their
equity, knowing that with limited liability, their own losses cannot exceed their equity.
Liberalisation, which facilitates increased risk-taking, heightens the probability of the
occurrence of agency conflicts, thus leading to decreased managerial prudence, greater
financial fragility and often precipitating financial crises.
Third, moral hazard may increase with the erosion of bank franchise value once ceilings are
lifted on deposit interest rates and entry barriers are reduced. Because increased bank
competition causes monopolistic profits to disappear, the costs of losing a banking licence
when the bank becomes insolvent decrease and incentives to take on riskier loans increase.
Fourth, rapid balance sheet growth can also contribute to financial crises following
liberalisation (Llewellyn, 1998: 257). Such growth, which can also result from the abolition
of interest rate ceilings and credit controls, almost inevitably involves banks incurring more
risk and becoming more vulnerable. The reasons for this include, inter alia: the tendency for
control systems to weaken in periods of rapid balance sheet growth; the unwarranted
optimism which is generated by growth; and the likelihood of unbalanced portfolios when
new lending opportunities are concentrated in a narrow range of business sectors.
Fifth, financial liberalisation may also lead to temporary liquidity shortages, when interest
rates are more volatile. This in turn may necessitate government intervention of some form
which increases moral hazard (Stiglitz, 1994: 27). Thus, inappropriate risk-taking and
heightened financial fragility again increase as a result of financial liberalisation.
The actualisation of these theoretical arguments has been clearly evident in Jamaica. As
outlined in section 2, following the second, accelerated phase of financial liberalisation, risktaking by financial institutions increased significantly. This was evidenced by the
deterioration in the quality of the rapidly expanding loan portfolios, and the exceedingly high
levels of NPLs. Instances of financial imprudence due to inexperience, over-work of loan
staff, agency conflicts between managers/owners and depositors, unwarranted optimism in
the economy or in particular sectors, innovative but risky attempts to maintain market share,
related-party transactions, managerial overspending, and the perception of government
guarantees, are numerous. The rapid growth in the financial sector, induced by liberalisation,
placed pressure on the management of financial institutions and on the supervisory
authorities, and thus exposed managerial and legislative inadequacies, which in turn
contributed to the liquidity and solvency problems that later emerged (Stennett et al., 1998:
22).
In a liberalised financial system, the government plays an important role in regulating the
system and in establishing the corrective incentives to encourage prudential and productive
behaviour (Brownbridge and Kirkpatrick, 2000; Caprio and Honohan, 1999). However, in
Jamaica, such incentives were undermined for several reasons. Insider transactions were rife
due to crony capitalism and the existence of large conglomerates. The interconnection of
financial institutions and between financial institutions and the corporate sector exacerbated
the regulatory problems, as the transparency of relations and the accuracy of information
could not be guaranteed. Consequently, transactions were being shifted between member
8
companies of the same corporate group, thus allowing, inter alia, the group to determine
where losses were to be located.
In addition to these adverse incentives, it is widely acknowledged that the regulatory and
supervisory systems in Jamaica had numerous weaknesses in the post-liberalisation period.5
Although reforms to the financial legislation and supervisory systems were implemented in
the post-liberalisation period, the manner of implementation was found wanting in many
respects. A commonly cited example is the excessive flexibility given to bank managers
when classifying and provisioning for loan losses. An amendment to the Banking Act in
1992 made it mandatory for commercial banks to make provisions for NPLs six months and
over, however, it was only in 1996 that loans past due for three months were classified as
non-performing. Consequently loan loss provisions in Jamaica were inadequate to provide
cover against likely losses, which meant that earnings and capital levels were overstated. If
capital levels had been accurately computed, banks would have had to restrain the rapid
growth of their lending, or raise new capital, in order to maintain compliance with the capital
adequacy requirements, and as such would have been less vulnerable to financial distress
(Brownbridge and Kirkpatrick, 1999: 17).
It is also acknowledged that even where effective regulations were in place, they were often
not properly enforced. This was caused by inadequate supervisory capacity in the central
bank, and also by restrictive legislation limiting the ability of the Minister of Finance to
intervene in distressed institutions.6
4.
GOVERNMENT RESPONSE TO THE CRISIS AND ITS CRITICS
In this section we describe the government’s response to the crisis, and identify the main
criticisms that have been made of it. The response has progressed in two distinct phases – an
initial response followed by a reassessment of the situation and a change in modus operandi.
The Government’s Initial Response
The Jamaican government’s initial response to the crisis was relatively straightforward and
was not complicated by the exigencies of having to deal with the simultaneous occurrence of
a currency crisis. In 1994, numerous weaknesses were uncovered in a group of financial
institutions called the Blaise Financial Entities (BFEs). When these problems were fully
revealed, it was noted that the institutions were insolvent and plagued by a co-mingling of
assets and liabilities and high levels of related-party loans. In December 1994, the
government intervened and placed the BFEs under Temporary Management while a Scheme
of Arrangement was developed. In a decision that completely shaped the rest of the
government’s crisis management efforts, it was announced that the BFE’s 3,800 depositors
would be fully protected by the government, and were to be reimbursed the full amount of
their deposits (J$972.1 million). The payment to depositors was financed by budgetary
allocations, and an Executive agency – FIS – was incorporated in October 1995 primarily to
implement the provisions of the Scheme of Arrangement. FIS was also mandated to pursue
recovery of all assets of the BFEs in order to minimise the burden on the budget, and pursue
civil litigation against former directors and shareholders of the institutions deemed
responsible for their demise (Davies, 1998: 1).
Due to this comprehensive intervention by the government, relative calm was restored to the
Jamaican financial sector until July 1995, when the problems of another financial
9
conglomerate – the Century Financial Entities (CFEs) – were made public.7 The government
placed the CFEs under Temporary Management in July 1996 and again decided to protect the
CFEs’ 43,000 depositors, at a cost to the public sector of approximately J$10 billion. This
decision was taken by the government both to protect the depositors immediately affected,
and more importantly, to maintain the public’s confidence in the local financial sector. The
government’s resolve was, however, tested by a run on another commercial bank in October
1996. Its management, however, was able to withstand the pressure and avoid an overdraft at
the central bank. The Minister of Finance and the Bank of Jamaica quickly moved to restore
confidence by reassuring the public of the soundness of the financial system and the
government’s support of it (BOJ, 1996).
During this time, the government did not change either its monetary or fiscal policies in
response to the emerging crisis. From as early as 1991, the government pursued tight
demand management policies with the aim of reducing a burgeoning inflation rate which
reached 80 per cent in 1991. Interest rates were consistently high (average savings and
lending rates reaching their maximum levels in 1994, 19.3 per cent and 66.9 per cent
respectively), but as inflationary expectations were dampened, interest rates were gradually
reduced. Consistent with such demand management policies, the government maintained an
increasing fiscal surplus from 1991/92 to 1994/95, which was then allowed to decrease (BOJ,
1999: 100).
Thus, it is evident that the Jamaican government maintained its composure in responding to
the initial onset of the financial crisis. Depositors were protected, the public’s confidence
was restored, and fiscal and monetary targets were maintained. This, however, was at a high
cost to the public purse, for the benefit of a relatively small proportion of the population.
Critics complained of the poor taxpayers having to “bail-out” the rich. The government was
criticised for not intervening in the distressed institutions sooner, and for not exercising
greater vigour in prosecuting the persons responsible for their collapse. Another more
fundamental criticism focuses on the issue of moral hazard. Many critics argued that the
government’s actions in guaranteeing the deposits in the failed entities created the perception
by all depositors and institutions that they were similarly protected. This fostered greater
incentives for risk taking and imprudence by both savers and lenders.
Comparison of the much-publicised IMF response in South East Asia to that of Jamaica, adds
another dimension to the argument. It is evident that one of the major differences in response
in the two regions relates to the issue of public confidence. The IMF gave explicit directives
to close banks and financial institutions without protecting depositors which severely eroded
the public’s confidence in the financial system, and worsened the extant financial panic
(Bullard et al., 1998: 88, 94; Hahm, 1999: 133; Radelet and Sachs, 1998: 53, 62). This had
dire consequences not only on the financial sector, but also on the real economy, causing
severe social hardships (Kregel, 1998: 59; Nixson and Walters, 1999: 498). These
consequences were largely avoided in Jamaica, because the government assumed the
responsibility of protecting depositors and thus maintained public confidence. This bound
the government however, to an immensely costly course of action once the true depth of the
crisis was revealed.
The Government’s Response as the Crisis Deepened
In July 1996, representatives of the life insurance industry approached the Jamaican
government and requested assistance to address problems that had emerged in that sub-sector,
10
and had spilled over into the commercial banking sector. The Minister of Finance asked a
team of specialists to determine the extent and nature of the problems in the financial sector,
and to develop appropriate solutions. The team recommended that the government intervene
in the sector in a comprehensive manner, addressing the problems of illiquidity and
insolvency, as well as problems related to weak management, the structure of ownership and
control, and the regulatory framework (Davies, 1998: 2-3).
The Jamaican government established FINSAC in January 1997 to undertake these functions.
Upon its formation, FINSAC embarked upon a three-phased course of action to be completed
over its expected five to seven year life span. The phases are known as intervention,
rehabilitation and divestment (FINSAC, 1998: 12).
Intervention usually involved FINSAC “stepping in” to assist troubled institutions with an
injection of capital. In exchange, FINSAC acquired a combination of equity, board seats and
other assets. Occasionally, FINSAC’s intervention has taken the form of take over and/or
closure, but such actions are last resorts reserved for deeply distressed institutions. When this
has happened, FINSAC took on the deposit liabilities of the intervened institution and placed
matching funds in replacement accounts at a stable institution. This was done so as to ensure
that depositors have uninterrupted access to their deposits. This is all funded by governmentguaranteed securities. This phase left FINSAC with equity and/or board seats in four of the
island’s nine commercial banks, five of its twelve life insurance companies, and two
merchant banks (Davies 1998: 3).
Following intervention, FINSAC proceeded to the rehabilitation phase. Intervened banks are
relieved of their bad loans so that they can focus on their own rehabilitation (FINSAC, 1999:
20). Additionally, the entities are required to strengthen their credit evaluation systems and
loan portfolio management, and to implement improved internal accounting controls (Davies,
1998: 4).
As part of the rehabilitation phase, FINSAC also attempted to restructure the financial sector
through mergers and closures as appropriate. At the end of June 1999, Union Bank Ltd. was
created as a result of the merger of three commercial banks and two merchant banks.
FINSAC also assisted the country’s largest commercial bank (NCB), by providing financing
of J$19.5 billion and facilitating the development of a plan for the bank’s rehabilitation
(FINSAC, 1999: 14). Similar activities took place in the life insurance industry, where
FINSAC facilitated the sale of the combined portfolios of three life insurance companies, and
transferred the management of their pension schemes to two major, viable life insurance
companies.
The government also focused its attention on regulatory and supervisory reform. A Task
Force was established to examine the existing legislation, with a view to strengthening the
rules and standards governing the financial sector. As a result of the recommendations of the
Task Force, key amendments to the legislation came into effect in October 1997.8
Additionally, the Deposit Insurance Act was passed in March 1998, to establish a scheme for
the protection of depositors.
FINSAC’s third and final phase – divestment – involves the return of the real estate, shares
and businesses acquired by FINSAC, to private hands. The intention is to both maximise the
selling price of its assets, and to ensure that the resultant configuration of the financial sector
is optimal. As at December 1999, FINSAC had sold J$6.6 billion of assets, and sales of
11
assets valued at a minimum of J$4.1 billion were expected to be conducted in the following
six to nine months (Davies, 1999: 2-3).
This, however, falls far below the government’s total expenditure on the restructuring of the
financial sector. At the end of February 2000, FINSAC had total debt (principal plus interest)
of approximately J$108 billion. About J$38 billion was owed to other government agencies,
and the remaining J$70 billion was owed to third party creditors. While means of clearing
the intra-public sector debt are relatively easy to decipher, the issue of solving the third party
obligation remains a major concern.
This has been one of the main criticisms of the Jamaican response to the financial sector
crisis. Most commentators agree that the government’s intervention was necessary, and have
supported, for the most part, FINSAC’s modus operandi, but have expressed concern about
the cost of the intervention. Chen-Young (1998: 10, 14) notes that, “there is no doubt that
FINSAC’s intervention in the financial sector was vital, if late, and that it helped to restore
confidence and stability”, (but) “the FINSAC debt… could (represent)… approximately twothirds of GDP, more than triple that in Indonesia (20 per cent), six times that in Thailand (10
per cent), and nearly five times that in Mexico (14.4 per cent). Public sector debt is now a
matter of grave concern…”
Chionesu (2000: 11) further argues that, “the stability of the Jamaican economy and the
financial sector… are threatened by a burgeoning public debt… Growth of the debt stock and
servicing demands have enlarged the public deficit to the point where the existing stock
cannot be serviced by current tax revenues.” The prospect of medium term public insolvency
(as indicated by an estimated debt-GDP ratio of between 130 per cent-140 per cent, inclusive
of net FINSAC obligations) raises the question of the capability of the economy to service
additional debt, with implications for the financial sector’s stability given the public debt
exposure of numerous financial institutions.
5.
WHAT IF? A STUDY OF THE COUNTERFACTUAL
Section 4 provided a detailed account of the Jamaican financial crisis and the government’s
response to it. This section attempts to develop an ex-post evaluation of the impact of the
policies that were adopted in response to the crisis. An effective measure of the impact of a
policy response is to compare performance under that response to the ‘counterfactual’.9 Such
measures define the effectiveness of the policy response as the difference between the actual
macroeconomic performance observed consequent to the policy response, and the
performance that would have been expected in the absence of such a response (Goldstein and
Montiel, 1986: 305). However, the counterfactual cannot, by definition, be observed and
must be estimated or approximated. This section develops a hybrid method of estimating the
hypothetical counterfactual to the Jamaican government’s actual response, which is used to
explore the consequences of the alternative response which was available to the Jamaican
government, namely, to request IMF assistance.
The Simulated With-Without Approach
The approach adopted first assumes that market forces could not be relied on to resolve the
problems of the Jamaican financial sector, and that some form of government intervention
was necessary. Thus, a counterfactual to the Jamaican government’s response was developed
by creating a hypothetical IMF programme in response to the financial crisis. The actual
12
effects of the Jamaican government’s response will therefore be compared to the simulated
effects of the hypothetical response, so as to obtain an estimate of the impact of the
government’s response. The results of the simulated with-without approach are summarised
Table 1. The analysis is divided into five key areas: the financial sector, other structural
concerns, monetary policy, fiscal policy and financing the responses. Columns a, b and c of
the table summarise the findings of previous sections, and columns d and e briefly outline the
hypothesised IMF response and the expected effects. The comparison of columns c and e
will allow conclusions to be drawn about the impact of the Jamaican government’s response.
A strict adherence to the traditional with-without approach was rejected. This approach
would have entailed a comparison of the consequences of the Jamaican response to the
effects of the IMF programmes in Thailand, Indonesia and Korea (the control group of
countries assumed to be the counterfactual). However, the differences in the external and
macroeconomic environments of these two regions, particularly the capital flight and
currency crisis which affected South East Asia but which were absent in Jamaica, make this
approach unsuitable. Similarly, the traditional use of the comparison-of-simulations
approach was rejected because of the desire to avoid the problems inherent in developing
complex econometric models.
However, principles from both methodologies were utilised in developing the hybrid. The
principle of comparing the consequences of an actual policy response with the simulated
effects of a ‘modelled’ response was adopted from the comparison-of-simulations approach.
While, from the with-without approach, the comparison of the experience in South East Asia
with Jamaica, when appropriately modified, proved to be feasible in developing the simulated
IMF response and consequences. The simulated with-without approach draws heavily on the
experiences in Thailand, Indonesia and Korea, in addition to the IMF’s public statements
with respect to the Jamaican financial crisis. However, this hybrid model is inevitably more
qualitative and subjective than other approaches, reflecting the authors’ judgement and
interpretation of events.
Table 1: A Counterfactual Assessment of Jamaica’s Policy Response to Financial Crisis
13
Conditions Prior to
Response (a)
With: Actual Scenario
Policy Response
(b)
Effect (c)
Without: Hypothesised IMF
Scenario
Policy Response
Effect (e)
(d)
The Financial
Sector
- Initially liquidity
- Rapid expansion of support provided
financial sector
through the central
following
bank.
liberalisation.
- The government
- Emergence of large intervened in the
financial
distressed
conglomerates, which institutions usually
diversified out of
through capital
core business and
injections, in
were plagued by
exchange for
connected party
equity, board seats
transactions.
and assets.
- High levels of
Occasionally
NPLs.
institutions were
- Declining
closed.
profitability in the
- deposits were
sector.
protected, and
- Deterioration in the repeated assurances
banking system’s
were given as to the
capital base.
government’s
- Mismatch of assets
support of the
and liabilities.
financial system.
- Liquidity problems - A financial
in the life insurance
restructuring
and banking
agency – FINSAC
industries
was created to aid
precipitated by the
in the restructuring
imprudent overof the sector.
investment in real
- Creation of ‘good
estate and equity, and bank/bad bank
the subsequent
scenario’ to relieve
collapse of these
banks of NPLs.
markets.
- The consolidation
- Impending panic
and rationalisation
within the domestic
of the sector
financial system, as
through mergers,
problems within
closures, and sale to
numerous institutions overseas entities, as
were revealed.
appropriate.
- Regulatory and
supervisory reform.
- The divestment of
equity and assets
- Relative calm
was maintained
within the
financial sector.
Apart from a
‘flight to quality’
within the
domestic system,
there was no
wholesale
financial panic,
nor international
capital flight. The
relatively smooth
operation of the
financial sector
was preserved, as
depositors’
confidence in the
system was
bolstered.
- Possible moral
hazard, which
may have fostered
greater incentives
for risk taking and
imprudence by
savers and
lenders. (Attempts
to avoid this in
the future include
the creation of a
Deposit Insurance
Scheme).
- Leaner, more
efficient financial
sector.
- Improved
regulatory and
supervisory
structure.
- Exposure of
numerous
financial
14
- Initially,
immediate
closure/suspension
of troubled
institutions, without
arrangements to
protect depositors.
- Eventual
moderation of
stance, with more
focus placed on
recapitalisation of
institutions, and
restoration of
public’s
confidence.
- Restructuring of
the industry to
proceed in a
manner similar to
that under
FINSAC’s mode of
operation (see
column b and
chapter 4).
- Loss of public
confidence in
the financial
sector, financial
panic, and
international
capital flight.
- Crippling of
the domestic
financial
system, and
consequent
credit crunch.
- Contraction in
economic
activity.
- Pressure
placed on the
currency
because of the
capital flight,
either resulting
in a depreciation
of the exchange
rate, or
constrictive
corrective
measures by the
government.
- Social unrest
as the public
reacts to the loss
of deposits.
- Impact
following
change in IMF’s
stance positive
but slow, with
FINSAC’s task
being more
difficult and
costly, because
of IMF’s initial
mistakes.
Conditions Prior to
Response (a)
With: Actual Scenario
Policy Response
(b)
Effect (c)
Without: Hypothesised IMF
Scenario
Policy Response
Effect (e)
(d)
The Financial
Sector
- Initially liquidity
- Rapid expansion of support provided
financial sector
through the central
following
bank.
liberalisation.
- The government
- Emergence of large intervened in the
financial
distressed
conglomerates, which institutions usually
diversified out of
through capital
core business and
injections, in
were plagued by
exchange for
connected party
equity, board seats
transactions.
and assets.
- High levels of
Occasionally
NPLs.
institutions were
- Declining
closed.
profitability in the
- deposits were
sector.
protected, and
- Deterioration in the repeated assurances
banking system’s
were given as to the
capital base.
government’s
- Mismatch of assets
support of the
and liabilities.
financial system.
- Liquidity problems - A financial
in the life insurance
restructuring
and banking
agency – FINSAC
industries
was created to aid
precipitated by the
in the restructuring
imprudent overof the sector.
investment in real
- Creation of ‘good
estate and equity, and bank/bad bank
the subsequent
scenario’ to relieve
collapse of these
banks of NPLs.
markets.
- The consolidation
- Impending panic
and rationalisation
within the domestic
of the sector
financial system, as
through mergers,
problems within
closures, and sale to
numerous institutions overseas entities, as
were revealed.
appropriate.
- Regulatory and
supervisory reform.
- The divestment of
equity and assets
- Relative calm
was maintained
within the
financial sector.
Apart from a
‘flight to quality’
within the
domestic system,
there was no
wholesale
financial panic,
nor international
capital flight. The
relatively smooth
operation of the
financial sector
was preserved, as
depositors’
confidence in the
system was
bolstered.
- Possible moral
hazard, which
may have fostered
greater incentives
for risk taking and
imprudence by
savers and
lenders. (Attempts
to avoid this in
the future include
the creation of a
Deposit Insurance
Scheme).
- Leaner, more
efficient financial
sector.
- Improved
regulatory and
supervisory
structure.
- Exposure of
numerous
financial
15
- Initially,
immediate
closure/suspension
of troubled
institutions, without
arrangements to
protect depositors.
- Eventual
moderation of
stance, with more
focus placed on
recapitalisation of
institutions, and
restoration of
public’s
confidence.
- Restructuring of
the industry to
proceed in a
manner similar to
that under
FINSAC’s mode of
operation (see
column b and
chapter 4).
- Loss of public
confidence in
the financial
sector, financial
panic, and
international
capital flight.
- Crippling of
the domestic
financial
system, and
consequent
credit crunch.
- Contraction in
economic
activity.
- Pressure
placed on the
currency
because of the
capital flight,
either resulting
in a depreciation
of the exchange
rate, or
constrictive
corrective
measures by the
government.
- Social unrest
as the public
reacts to the loss
of deposits.
- Impact
following
change in IMF’s
stance positive
but slow, with
FINSAC’s task
being more
difficult and
costly, because
of IMF’s initial
mistakes.
Conditions Prior to
Response (a)
With: Actual Scenario
Policy Response
(b)
Effect (c)
Without: Hypothesised IMF
Scenario
Policy Response
Effect (e)
(d)
The Financial
Sector
- Initially liquidity
- Rapid expansion of support provided
financial sector
through the central
following
bank.
liberalisation.
- The government
- Emergence of large intervened in the
financial
distressed
conglomerates, which institutions usually
diversified out of
through capital
core business and
injections, in
were plagued by
exchange for
connected party
equity, board seats
transactions.
and assets.
- High levels of
Occasionally
NPLs.
institutions were
- Declining
closed.
profitability in the
- deposits were
sector.
protected, and
- Deterioration in the repeated assurances
banking system’s
were given as to the
capital base.
government’s
- Mismatch of assets
support of the
and liabilities.
financial system.
- Liquidity problems - A financial
in the life insurance
restructuring
and banking
agency – FINSAC
industries
was created to aid
precipitated by the
in the restructuring
imprudent overof the sector.
investment in real
- Creation of ‘good
estate and equity, and bank/bad bank
the subsequent
scenario’ to relieve
collapse of these
banks of NPLs.
markets.
- The consolidation
- Impending panic
and rationalisation
within the domestic
of the sector
financial system, as
through mergers,
problems within
closures, and sale to
numerous institutions overseas entities, as
were revealed.
appropriate.
- Regulatory and
supervisory reform.
- The divestment of
equity and assets
- Relative calm
was maintained
within the
financial sector.
Apart from a
‘flight to quality’
within the
domestic system,
there was no
wholesale
financial panic,
nor international
capital flight. The
relatively smooth
operation of the
financial sector
was preserved, as
depositors’
confidence in the
system was
bolstered.
- Possible moral
hazard, which
may have fostered
greater incentives
for risk taking and
imprudence by
savers and
lenders. (Attempts
to avoid this in
the future include
the creation of a
Deposit Insurance
Scheme).
- Leaner, more
efficient financial
sector.
- Improved
regulatory and
supervisory
structure.
- Exposure of
numerous
financial
16
- Initially,
immediate
closure/suspension
of troubled
institutions, without
arrangements to
protect depositors.
- Eventual
moderation of
stance, with more
focus placed on
recapitalisation of
institutions, and
restoration of
public’s
confidence.
- Restructuring of
the industry to
proceed in a
manner similar to
that under
FINSAC’s mode of
operation (see
column b and
chapter 4).
- Loss of public
confidence in
the financial
sector, financial
panic, and
international
capital flight.
- Crippling of
the domestic
financial
system, and
consequent
credit crunch.
- Contraction in
economic
activity.
- Pressure
placed on the
currency
because of the
capital flight,
either resulting
in a depreciation
of the exchange
rate, or
constrictive
corrective
measures by the
government.
- Social unrest
as the public
reacts to the loss
of deposits.
- Impact
following
change in IMF’s
stance positive
but slow, with
FINSAC’s task
being more
difficult and
costly, because
of IMF’s initial
mistakes.
Conditions Prior to
Response (a)
With: Actual Scenario
Policy Response
(b)
Effect (c)
Without: Hypothesised IMF
Scenario
Policy Response
Effect (e)
(d)
The Financial
Sector
- Initially liquidity
- Rapid expansion of support provided
financial sector
through the central
following
bank.
liberalisation.
- The government
- Emergence of large intervened in the
financial
distressed
conglomerates, which institutions usually
diversified out of
through capital
core business and
injections, in
were plagued by
exchange for
connected party
equity, board seats
transactions.
and assets.
- High levels of
Occasionally
NPLs.
institutions were
- Declining
closed.
profitability in the
- deposits were
sector.
protected, and
- Deterioration in the repeated assurances
banking system’s
were given as to the
capital base.
government’s
- Mismatch of assets
support of the
and liabilities.
financial system.
- Liquidity problems - A financial
in the life insurance
restructuring
and banking
agency – FINSAC
industries
was created to aid
precipitated by the
in the restructuring
imprudent overof the sector.
investment in real
- Creation of ‘good
estate and equity, and bank/bad bank
the subsequent
scenario’ to relieve
collapse of these
banks of NPLs.
markets.
- The consolidation
- Impending panic
and rationalisation
within the domestic
of the sector
financial system, as
through mergers,
problems within
closures, and sale to
numerous institutions overseas entities, as
were revealed.
appropriate.
- Regulatory and
supervisory reform.
- The divestment of
equity and assets
- Relative calm
was maintained
within the
financial sector.
Apart from a
‘flight to quality’
within the
domestic system,
there was no
wholesale
financial panic,
nor international
capital flight. The
relatively smooth
operation of the
financial sector
was preserved, as
depositors’
confidence in the
system was
bolstered.
- Possible moral
hazard, which
may have fostered
greater incentives
for risk taking and
imprudence by
savers and
lenders. (Attempts
to avoid this in
the future include
the creation of a
Deposit Insurance
Scheme).
- Leaner, more
efficient financial
sector.
- Improved
regulatory and
supervisory
structure.
- Exposure of
numerous
financial
17
- Initially,
immediate
closure/suspension
of troubled
institutions, without
arrangements to
protect depositors.
- Eventual
moderation of
stance, with more
focus placed on
recapitalisation of
institutions, and
restoration of
public’s
confidence.
- Restructuring of
the industry to
proceed in a
manner similar to
that under
FINSAC’s mode of
operation (see
column b and
chapter 4).
- Loss of public
confidence in
the financial
sector, financial
panic, and
international
capital flight.
- Crippling of
the domestic
financial
system, and
consequent
credit crunch.
- Contraction in
economic
activity.
- Pressure
placed on the
currency
because of the
capital flight,
either resulting
in a depreciation
of the exchange
rate, or
constrictive
corrective
measures by the
government.
- Social unrest
as the public
reacts to the loss
of deposits.
- Impact
following
change in IMF’s
stance positive
but slow, with
FINSAC’s task
being more
difficult and
costly, because
of IMF’s initial
mistakes.
The Hypothesised IMF Response to the Jamaican Financial Crisis
The hypothesised IMF response to the Jamaican financial crisis and the simulated effects are
based on two key assumptions. First, it is assumed that the IMF programme would have
commenced subsequent to the deepening of Jamaica’s financial crisis, that is, in mid to late
1996. This means that the IMF would be in the initial phase of its response to the South East
Asian crisis. Based on the IMF’s track record, and on the obvious similarities between the
two crises, it is reasonable to assume there would be significant commonalities between the
two programmes. Second, it is assumed that the Jamaican government implements all the
IMF’s conditionalities. As reflected in Table 1, the IMF’s response is hypothesised to have
focused on the following key areas:
•
The Financial Sector
The immediate closure/ suspension of numerous troubled institutions was an integral part of
the IMF’s initial response to the SEA crisis (Bullard et al., 1998: 88, 94; Hahm, 1999: 1333).
Such measures were seen as being necessary to “…arrest further deterioration and signal the
governments’ resolve…” (Hamann and Ghattas, 1999: 69). The hypothesised IMF response
in Jamaica includes a similar proviso and the simulated effect is based on Radelet’s and
Sachs’ (1998: 62) ‘logic of creditor panics’, and is evidenced by the consequences in South
East Asia. It is expected that the closure of financial institutions in the absence of
arrangements to protect depositors, would lead to wholesale financial panic in Jamaica.
There would be international capital fight, and even the local branches of foreign institutions
would be undermined by the lack of confidence shown by the IMF and the government in the
entire financial sector. As in SEA, the domestic financial system would be damaged, and the
real economy would be adversely affected by the consequent credit crunch, leading to a
further contraction in economic activity. Also, international capital flight would put a strain
on the currency, leading to a significant depreciation in the exchange rate, or alternatively, to
constrictive corrective measures by the government. Furthermore, the Jamaican public,
especially in light of the previous protection of the Blaise and Century depositors, would
react adversely to the loss of deposits and social unrest is probable.
However, it is also assumed that as the IMF learned from the SEA crisis, such knowledge
would be applied in Jamaica.10 An eventual moderation of this initial stance is theorised, with
a shift in focus from bank closures, to the recapitalisation of weak institutions, and the
issuance of government guarantees for bank liabilities.11 Also, based on the IMF’s validation,
it is assumed that FINSAC, with its three-pronged approach would be a feature of the IMF’s
moderated response.
As in SEA, the simulated effect of this change in stance by the IMF is positive, but slow,
reflecting the damage already done to the public’s confidence in the financial sector.
FINSAC’s task is made more difficult, and the cost of restructuring is magnified.
•
Other Structural Concerns
An increasingly popular theme in all IMF programmes is the focus on structural reforms.12
Generally, these reforms are aimed at reducing government-imposed distortions and other
structural and institutional rigidities that impair the efficient allocation of resources and
18
hinder growth (Mussa and Savastano, 1999: 22). In SEA, “the structural reform strategy in
the programmes was exceptionally comprehensive” (Lane, 1999a: 18), and incorporated a
wide range of policies beyond the immediate financial crisis, including trade liberalisation,
demonopolisation and privatisation (Radelet and Sachs, 1998: 67).
It is assumed that similar reforms would be insisted on in Jamaica. This is justified by the
fact that even while lauding the government’s recent efforts at privatisation and trade
liberalisation, the IMF was calling for an increase in the extent and pace of the reforms, with
a comprehensive reform of the public sector being advocated (IMF, 1999a: 19). The
simulated impact of such reforms is, however, not as large as in SEA, as the Jamaican
government was already positioned to make these changes, and thus the pressure on the
government (as highlighted by Radelet and Sachs, 1998: 67-68) would not be as great .
•
Monetary Policy
IMF stabilisation programmes typically require a tightening of the country’s monetary policy
(Mussa and Savastano, 1999: 21). In SEA interest rates were raised sharply to restore
stability to foreign exchange markets (Camdessus, 1999). However, in Jamaica, interest rates
were already high due to anti-inflationary measures. While some increase would be expected
to aid in the stabilisation of the currency (necessitated by the IMF-induced capital flight), it is
hypothesised that the IMF would not have much scope for significantly changing Jamaica’s
monetary policy in the immediate post-crisis period.
•
Fiscal Policy
The same cannot be said of the country’s fiscal policy. It is assumed that the IMF would
attempt to make up for its lack of leverage over monetary policy, by a significant fiscal
tightening. Such proclivity is implied in the IMF’s 1999 Staff Report, where it is suggested
that in order to facilitate an easing of the monetary policy, a large fiscal adjustment should be
pursued. Furthermore, if fiscal tightening was required in SEA, where the fiscal positions
were strong relative to Jamaica, it seems reasonable to assume that similar measures should
be included in the hypothesised response, even if only for “covering the prospective…costs
of financial sector restructuring” (Lane, 1999a: 18).
Thus, it is assumed that the IMF would require a significantly reduced fiscal deficit.
Measures to achieve this would include: elimination of most general consumption tax (GCT)
exemptions, increases in the rates for GCT, increases in the personal and corporate income
taxes, and increases in nonfuel excises. Also, expenditures would be cut by, inter alia,
rationalising the public sector, particularly in the health and education sectors (IMF, 1999a:
16,18,19).
The impact of such measures would be severe. In SEA there is now general consensus that
the IMF’s fiscal objectives were too tight (IMF, 1999b), and had a contractionary impact
(World Bank, 1999: 57). In Jamaica, the consequences would be magnified, as, in contrast to
SEA, the economy was already experiencing a recession in 1996. Any further contraction in
economic activity would push numerous households over the poverty line, worsened by the
fact that inflows of foreign capital and remittances, which previously acted as a cushion
against the impact of poverty, would be depleted because of the domestic financial panic.
19
Furthermore, many of the measures suggested by the IMF (1999a: 16,18,19) to reduce the
fiscal deficit, would directly affect the poor. For example, the exemptions on the GCT are
placed on staple food products and basic educational and health necessities. Removal of
these exemptions would price these goods out of the range of the poor. Reducing the size of
the public sector, while being necessary, would also create social hardships if pursued in a
period when unemployment is increasing (because of the large-scale rationalisation in the
financial sector, and the economic contraction), and when many of these public servants
would have lost all of their savings in failed institutions. These conditions, combined with
the politically sensitive move to increase the income tax, would create an environment ripe
for social unrest and upheaval, especially as public demonstrations and riots have been a
feature of Jamaica’s history. This in turn creates a recessionary cycle, as such social unrest
would have an immediate and disastrous impact on one of Jamaica’s major industries –
tourism, and would precipitate further international capital flight.
Again, although it is theorised that the IMF would respond to these negative results by
eventually relaxing its fiscal targets and implementing social policies (Radelet and Sachs,
1998: 60), it can be argued that as in SEA, these actions would be too little, too late. The
only positive long-run benefit that could reasonably be expected from this sequence of events
is the institutionalisation of social safety nets, which would aid in sheltering the poor from the
adverse effects of future economic crises (Camdessus, 1999).
•
Financing the Response
It is only in this last area of focus that a clear advantage of seeking the IMF’s assistance is
evident. The SEA economies benefited from very large official financing packages from the
IMF, and as is usually the case, other multilateral and bilateral funding followed (Lane and
Schulze-Ghattas, 1999: 20; Radelet and Sachs, 1998: 49). In Jamaica, due to the difference
in magnitude of the crises, the financial support would not need to be as large, but was
needed just as much. Financial support from the IMF would have the advantage of being
almost immediate (consequent on the meeting of conditionalities), low-cost, and flexible
(with debt rescheduling being more of an option than with private lenders). However, it can
also be argued that the nature of the IMF’s response increased the amount of funds required
to restore stability to the Jamaican financial sector.
To conclude, comparing the effects of the Jamaican government’s response (table 1, column
c), to the counterfactual – the simulated effect of the hypothesised IMF response (table 1,
column e), indicates that in all areas of concern, except that of financing the policy response,
the impact of the former was less harmful than that of the latter.
In the financial sector, relative stability, even with the risk of increased moral hazard, is
preferable to wholesale financial panic and collapse, with the consequential adverse effects
on the real economy. In the area of fiscal policy, although a growing deficit with the need for
substantial future tightening is a cause for concern, it again seems preferable to the economic
contraction and social upheaval envisioned under the IMF response. In the case of monetary
policy and other structural issues, although not much difference was predicted, it is expected
that the Jamaican government would tend to take a more gradualist position when necessary,
than the IMF. Finally, with regards to financing the response, it is evident that whereas IMF
financial support would be preferred to private finance, this would have been accessed only at
considerable social cost to the Jamaican economy and society by adhering to the attached
20
conditionalities. It is concluded, therefore, that the Jamaican government’s response to the
financial crisis was superior in terms of its economic impact, to that of the IMF.
6.
CONCLUSION AND LESSONS TO BE LEARNT FROM THE JAMAICA
CASE STUDY
Any research on financial crises quickly reveals the lack of consensus among academics,
policymakers and the wider public about the critical issues relating to the fundamental causes
of, and appropriate responses to, financial crises. However, if policymakers are to be more
effective in responding to such crises, the pool of knowledge on the nature of financial crises
must be broadened. Crises from various regions around the world must be researched and
analysed in an attempt to develop a better understanding of the way in which policies for
avoiding and recovering from such crises can be fashioned to meet the particular features and
conditions of the affected economy. This study of Jamaican experience has attempted to do
just that, by showing how the relative success of the Jamaican government’s response to
financial crisis was due in large measure to the formulation of policies which were
appropriate to the financial sector’s structure and history and to the broader social and
economic context of Jamaican society.
Although there has been no resolution to the debate about the appropriate responses to the
financial crisis in Jamaica, a number of tentative general principles for recovery can be
derived.
The first principle relates to the government’s approach to intervention in distressed
institutions in a period of financial panic. The Jamaican experience reflects the need for the
government to adopt an approach aimed at restoring the public’s confidence. The use of
public resources for bank restructuring and protection of deposits is usually necessary, but
should be complemented by strong incentives against future moral hazard. Typically, this
should include writing off bad debt against the capital of existing shareholders, replacing
bank management, and otherwise ensuring that those who benefited from earlier risky
behaviour bear a significant part of the cost of restructuring (World Bank, 1999: 94-95).
Secondly, the creation of institutions to carry through financial restructuring, such as
FINSAC, is advisable. Strong, independent, public agencies, with the political and legal
clout to implement difficult decisions are essential for successful financial restructuring.
These agencies should be responsible for evaluating financial institutions, their portfolios,
systems and management, and for restructuring the financial sector through mergers,
closures, or other appropriate means.
The revision of legislation to strengthen prudential regulation and supervision of the financial
sector is another vital complementary measure. Tightened loan classification and
provisioning requirements, improved disclosure, accounting and auditing standards, limits on
lending to shareholders and other connected parties, and strengthened rules to limit maturity
and currency mismatches are all desirable. However, it must be remembered that the priority
during periods of crisis is to keep credit flowing and to prevent the crippling of the financial
system. As such, banks should be given appropriate leniency during the crisis to meet these
regulatory standards (Stiglitz, 1999: 418).
Experiences both in Jamaica and other regions (importantly in South East Asia) have also
highlighted the important linkages between the financial sector and the real economy, and the
21
spin-off effects that a financial crisis can have on economic growth and development.
Consequently, an important element of recovery is the focus on the reduction of social
hardships. This should include ensuring food security, maintaining the purchasing power of
vulnerable households, and maintaining economic and social services for the poor, including
spending on education and healthcare (Stiglitz, 1999: 423-424). This will all require
significant expenditure by the government, and implies an expansionary rather than
contractionary fiscal policy.
These principles are admittedly very general, and intentionally avoid the contentious,
unresolved issues in the debate. Nevertheless, they provide useful guidelines for recovery
from future crises. It is, however, important to note that this analysis has focused solely on
the principles for recovering from a crisis, and has not considered the equally, or perhaps
more important, question of how to prevent such crises.13
The Jamaican case study also has a number of general implications for the broader debate on
the role of international financial institutions in financial crisis. It is widely agreed that large
injections of finance are needed to aid in the recovery from financial crises. For developing
countries, the first source of assistance will be the IMF, acting in its traditional role of
provider of short-term adjustment assistance. This is likely to be followed by longer-term
financial assistance from the Fund (and the other IFIs), under the Fund’s Poverty Reduction
and Growth Facility (previously the Enhanced Structural Adjustment Facility, ESAF).
For many developing countries, IMF assistance has failed to make a significant contribution
to a sustained recovery of the financial sector and economic growth. Conditions have often
aimed at a rapid balance of payments recovery, failing to allow for the supply side constraints
which must be eased for economic recovery to occur. Indeed, misguided policy may make
recovery more difficult if it damages the social capital or political stability upon which longterm economic growth depends, and fails to put in place the medium-term measures that are
needed to build up the supply of both governance and physical output (Mosley, 2000b:
37-38).14
This should not, and need not be the case. The IMF and other international financial
institutions no longer have a monopoly on economic expertise, and are not immune to poor
diagnoses and recommendations. Many developing countries have the economic, technical
and financial expertise, the knowledge of their own economy, and the commitment to reform,
which are needed for effective policy formulation and implementation. The IMF needs to
continue its financial support for countries experiencing financial crisis, but at the same time
to work in partnership with national stakeholders to refine and develop its role to better
reflect the realities of the policy environment in low-income economies.
22
Notes
23
1
2
3
4
5
6
7
8
9
10
11
12
13
14
The differences between the IMF and the World Bank’s Chief Economist at the time, is reflected in the titles of his
contributions to the debate (Stiglitz, 1998, 1999).
Mosley (2000a: 632 and 633) makes the same point with respect to development policy in general: “it is crucial to
the argument that ‘good policy’ and ‘bad policy’ should be seen as relative to the economy’s resources and state of
development, and not as absolutes … the design of both macro- and micro-policies in a developing country needs to be
sensitive to a country’s existing level of market and institutional development and its vulnerability to external shocks, as
well as to its social and political objectives”.
Tennant (2000) compares the financial systems and crises in Jamaica and South East Asia.
One example of this inefficiency is the excessive managerial expenses incurred by institutions throughout the
Jamaican financial sector, with the ratio of employee remuneration to average assets 3.3 per cent over averaging the
period 1991-1995, as compared to the United States benchmark of 1.6 per cent (Green, 1999: 23).
McBain (1997: 148) notes that the ‘regulation of financial institutions … has centred more on ensuring compliance
with monetary and foreign exchange objectives than with prudential requirements’.
See Davies (1999) for a detailed description of regulatory inadequacies.
From as early as 1993, the government was aware of numerous weaknesses in these institutions. Impending
illiquidity, imprudent credit and management practices, and the high levels of NPLs and related-party transactions are
just a few of the problems that were reported. For years the central bank provided overdraft facilities to the group’s
commercial bank while the government took a conciliatory stance, trying to negotiate a resolution strategy with the
CFE’s management.
The legislation that came into effect in October 1997 provided for, inter alia:
•
more efficient and effective powers for remedial action taken by the supervisory authorities in respect of
distressed institutions
•
reduced capacity for institutions to lend to, or invest in, related parties
•
a more stringent computation of capital adequacy
•
a more precise definition of NPLs and power for the supervisory authorities to prescribe accounting rules
•
greater control by supervisory authorities over changes of ownership and a stricter definition of a “fit and proper
person” for management, directors and owners of financial institutions (Davies, 1998: 4-5).
The counterfactual is defined as “a comparison of what is versus what would have been” (Guitan, 1982: 99). Khan
(1990) describes the four approaches that have traditionally been used to evaluate policy interventions, and have
commonly been applied to IMF programmes – before-after approach, the actual-versus-target approach, the withwithout approach and the comparison-of-simulations approach. Each of these approaches is associated with
methodological problems.
This is based on Lane and Phillips’ (1999: 27) concession with regard to SEA, that “the slowdown in economic
activity was dramatically different from that assumed in formulating the programmes, and its magnitude, once
appreciated, prompted revisions in economic policies”.
This is supported by the IMF’s positive assessment of Jamaica’s restructuring of the financial sector in its 1999
Staff Report (IMF 1999a:3).
See Mosley (2000b) for a defence of this role of the IMF in developing countries.
On crisis-prevention policies, see Demirguc-Kunt and Detragiache (1998a, b), Caprio and Honohan (1999),
Brownbridge and Kirkpatrick (2000).
Mosley (2000b) argues that the Fund has become more sensitive to these issues: ‘The Fund has made major gains
in recent years, in understanding of response-mechanisms within developing countries and in ability to meet the
financial needs of a wider range of countries and constituencies”.
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